That stock dragging down your portfolio all year? It might be worth more as a tax deduction than as an investment you keep hoping will recover. Welcome to capital loss harvesting—one of the most overlooked year-end tax strategies available to investors.
As December winds down, savvy investors aren't just reviewing performance. They're looking for opportunities to turn investment disappointments into tax savings. But like most tax strategies, capital loss harvesting comes with rules you need to understand before making moves you can't undo.
What Is Capital Loss Harvesting?
Capital loss harvesting is selling investments that have declined in value to realize a loss you can use to offset gains—and potentially reduce your ordinary income taxes. The key word is "realize." Until you actually sell, any loss is just on paper, and the IRS doesn't care about paper losses.
If you bought a stock for $10,000 and it's now worth $6,000, you have an unrealized loss of $4,000. Sell it before year-end, and you've converted that paper loss into a realized loss for your tax return. That $4,000 can offset $4,000 in gains elsewhere—or reduce your taxable income if you don't have enough gains to offset.
How Losses Offset Gains—and the $3,000 Limit
The IRS follows a specific ordering system. First, short-term losses offset short-term gains, and long-term losses offset long-term gains within their respective categories. Then, if you have a net loss in one category and a net gain in the other, they offset each other.
Here's where many taxpayers hit a ceiling: if your losses exceed your gains, you can only deduct up to $3,000 of excess losses against ordinary income each year ($1,500 if married filing separately). This is a firm limit with no exceptions.
Any losses beyond what you can use carry forward indefinitely to future tax years, maintaining their character as short-term or long-term. Next year, they follow the same rules—first offsetting gains, then up to $3,000 against ordinary income.
Why this matters:
An investor who realizes $50,000 in losses during a bad market year but has no gains to offset can only deduct $3,000 this year, leaving $47,000 to carry forward. Without future gains to offset, it would take nearly 16 years to fully utilize those losses through the $3,000 annual deduction alone.
Strategic implications:
If you expect future years with significant gains—perhaps from selling a business, real estate, or concentrated stock positions—harvesting losses now to carry forward can be valuable. But if you already have substantial carryforwards and don't expect significant gains, harvesting additional losses may not provide immediate benefit. Sometimes generating gains intentionally makes sense—rebalancing appreciated positions while you have losses to offset them.
A Practical Example
Say you have $15,000 in long-term gains from selling rental property, $2,000 in short-term gains from stock trades, and you're considering harvesting a $12,000 long-term loss and a $10,000 short-term loss.
If you harvest both: The $12,000 long-term loss offsets your $15,000 long-term gain, leaving $3,000 in net long-term gains. The $10,000 short-term loss offsets your $2,000 short-term gain, leaving $8,000 in net short-term losses. These then net against each other—your $8,000 short-term loss eliminates the remaining $3,000 long-term gain, leaving $5,000 in net short-term losses.
You deduct $3,000 against ordinary income this year; the remaining $2,000 carries forward. In the 24% bracket, that $3,000 deduction saves $720 in federal taxes—plus you've eliminated $17,000 in capital gains that would have been taxed, potentially saving another $2,500 or more.
The Wash Sale Rule: The Critical Limitation
The IRS prevents you from claiming a loss if you buy "substantially identical" securities within 30 days before or after the sale—a 61-day window total.
Substantially identical includes:
the exact same stock, options to acquire the same stock, or substantially identical mutual funds.
Generally NOT substantially identical:
different companies in the same industry (selling Exxon, buying Chevron), different index funds tracking different indexes (selling an S&P 500 fund, buying a total market fund), or bonds from different issuers.
If you trigger a wash sale:
The loss isn't permanently gone—it adds to your cost basis in the replacement shares. But you lose the ability to use that loss this tax year, defeating the purpose.
Navigating the Wash Sale Rule
Wait 31 days.
Sell, wait, then repurchase. The risk: the investment might increase during your waiting period.
Buy similar but not identical.
Sell your losing S&P 500 fund and immediately buy a total stock market fund. You maintain broad market exposure while harvesting the loss.
Double up, then sell.
Buy additional shares first, wait 31 days, then sell your original losing shares. You maintain continuous exposure but need capital to temporarily hold double your position.
Important Limitations
Retirement accounts don't apply.
Loss harvesting only works in taxable brokerage accounts. Losses in IRAs and 401(k)s have no tax impact—those accounts are already tax-sheltered.
Other harvestable assets:
Beyond stocks, you can harvest losses from mutual funds, ETFs, bonds, cryptocurrency (the wash sale rule currently doesn't apply to crypto, though this may change), and other capital assets. Real estate losses work differently under passive activity rules.
When Loss Harvesting Might Not Make Sense
When you expect to be in a higher tax bracket soon.
If your income will increase significantly next year and you don't have gains to offset this year, it might make sense to defer harvesting until the $3,000 ordinary income offset can reduce income taxed at higher rates. However, if you have gains to offset now, harvesting this year typically still makes sense.
When transaction costs outweigh benefits.
If the loss is small, the tax benefit might not justify the costs and complexity.
When you truly believe in the investment.
If you're confident the investment will rebound quickly, you might regret being out during the wash sale period.
December Timing Considerations
Stock trades typically settle in one business day (T+1). To realize a loss in 2025, execute the sale by December 30 at the latest—earlier is safer. Also check whether your mutual funds will make year-end capital gains distributions, which are taxable even if reinvested and might motivate harvesting losses to offset them.
Take Action Before Year-End
Capital loss harvesting lets you create immediate tax benefits from investment disappointments. The key points: losses first offset gains dollar-for-dollar, excess losses are limited to $3,000 per year against ordinary income, unused losses carry forward indefinitely, and the wash sale rule requires careful planning to maintain investment exposure.
At Desert Rose Tax & Accounting, we help clients identify loss harvesting opportunities, calculate tax impacts, and develop strategies that minimize taxes while keeping investment goals on track.
Give us a call at (520) 747-4964 or visit www.desertrosetax.com
to schedule a consultation before December 31.
Edward Ethington, CPA, CFP®, MBA
Desert Rose Tax & Accounting
Your Partner in Tax-Efficient Investing
(520) 747-4964
www.desertrosetax.com
This blog provides general information about capital loss harvesting and should not be construed as personal tax or investment advice. Tax laws are complex and change frequently. Investment decisions should consider factors beyond tax implications. Please consult with qualified tax professionals at Desert Rose Tax & Accounting for guidance specific to your situation.
